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Spotlight on 2011 ETF Fund Flows

Were ETF fund flows chasing or predicting performance in 2011?

Abraham Bailin, 12/14/2011

Over the course of the year, total U.S. exchange-traded fund cash flows have totaled $102 billion. With less than a month left in 2011, the year-to-date increase in U.S. ETF net assets under management rounds out to just more than 5%. The increase left total net assets at roughly $1.06 trillion at the end of November. Cash flows through 2011 have not, however, been uniformly positive. As we segment the universe, we find that year-to-date flows have been quite the mixed bag.

Here we take a peek into whether flows have been chasing or pre-empting performance. Where has the money been moving, and how have investors made out?

U.S. Stock Flows' Roller Coaster
Cash flows within the U.S.-stock space have proved more volatile than any other sector this year. Through 11 months of market action, monthly flows in the U.S.-stock asset class have seen 7 points of inflection, where flows moved from positive to negative or vice versa. Throughout the period, flows to the asset class seemed to closely track market performance.

Kicking off 2011, a whopping $11.3 billion flowed into the U.S.-stock asset class in January, in what can only be seen as a bout of substantial performance-chasing. Prior to the New Year, the broad U.S. equity market had run up for six solid months, returning nearly 20% over the period.

As the market continued its climb in February, flows followed suit. In line with its performance-chasing sentiment, the space shifted to outflows in March, as total returns fell into the red for the bulk of the month. Flows have continued in similar fashion, moving negative following drawdowns and positive following runups.

In aggregate, U.S.-stock ETFs have realized a $31.5 billion inflow. It would appear that performance-chasing hasn't necessarily been a waste of energy. A simple long-short strategy that merely invested according to the previous month's directional move would have returned just over 12%, whereas holding the broad U.S. equity market for the entire period would have left you essentially flat for the year to date.

International Stock: A Tale of Two Funds
The most publicized price competition in ETFs continued its trend as Vanguard MSCI Emerging Markets ETF VWO and iShares MSCI Emerging Markets Index EEM have continued to wage a one-sided asset battle in 2011. Year-to-date inflows to the VWO totaled just more than $7.4 billion, while outflows to EEM weighed in at $7.1 billion. Given that the funds track the same benchmark, the MSCI Emerging Markets Index, and that their primary difference is that EEM charges 0.69% annually against VWO's 0.22%, we believe this to be quite a bout of cannibalization. For the year to date, both products are down 16.5%.

Despite the offsetting flows of VWO and EEM, the international-stock asset class saw year-to-date net inflows of $13.5 billion. VWO's inflow was followed by iShares MSCI EAFE EFA, iShares MSCI Japan EWJ, and Vanguard MSCI EAFE ETF VEA, which collected $4.3 billion, $2.2 billion, and $1.9 billion, respectively. While all three outperformed the MSCI Emerging Markets Index, the best performer, EFA, lost 10.6% for the year to date.

Flows to the international-stock offerings were nearly as volatile as those of their U.S.-stock counterparts. Thus far, net flows to the asset class have shifted from inflows to outflows (or back) six times in 2011. Since late March of this year, both the foreign and emerging markets have maintained similar performance. Not surprisingly, there were only two months in which the cash flows of VWO and EFA did not move in the same direction. For the first five months of 2011, flows responded to performance of the prior month. Since May, however, flows remained largely positive despite poor performance. The divergence may be the result of market participants looking to build out international exposure on the dips.

Outside of EEM, the only other major year-to-date outflow to the international-stock asset class came to iShares S&P Latin America 40 Index ILF, which shed $1.2 billion. The fund's benchmark sank 16.3% for the year to date.

Foresight Pays Off in the Taxable-Bond Space
Whereas flows have been jumpy within the equity markets, in many cases indicating strong trend following sentiment, persistent uncertainty and muddled market sentiment have driven a string of stable inflows to the taxable-bond asset class.

Despite being down a good deal of the period and ending essentially flat, the first four months of 2011 saw the taxable-bond space pick up roughly $10 billion in net assets. As the sector moved into the black following April, inflows held firm. For the year to date, the taxable-bond asset class has raked in $37 billion. By that metric, the taxable-bond asset class has claimed the single-largest asset-class-level inflow.

It may have been the case that flows to this space were predicting decent future returns. Perhaps the lack of market certainty had investors parking cash in taxable-bond ETFs, and returns merely came with a stroke of luck. In either case, the persistence paid off, as the total year-to-date return sits at roughly 9.3%.

Falling in line with the shift to more-certain investments, Vanguard Total Bond Market ETF BND rallied $4.4 billion for the year to date, second only to VWO for the period. Within the asset class, BND was trailed by iShares iBoxx $ High Yield Corporate Bond HYG and iShares iBoxx $ Invest Grade Corporate Bond LQD. Both funds gathered year-to-date inflows of roughly $2.9 billion.

Perhaps strengthening the argument that uncertainty drove flows to the taxable-bond asset class, iShares Barclays Short Treasury Bond SHV realized the largest year-to-date outflow in the space, shedding roughly $1.1 billion. SHV was followed by iShares Barclays 20+ Year Treasury Bond TLT, which gave up $381 million.

Abraham Bailin is an ETF Analyst with Morningstar.
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